Clarifying Some Confusion on Inequality over the Ages

June 2nd, 2014 at 7:26 pm

There’s now a pretty active cottage industry of analysts pointing out that Piketty’s inequality analysis is incomplete because it leaves out the impact of taxes and transfers. It’s an important point; one I’ve made as well. Including the impact of taxes and transfers is particularly important when you’re analyzing poverty or the well-being of low-income households, since safety net benefits and social insurance programs, such as Social Security, Medicare, or nutritional support, make an obvious and positive difference in the economic lives of their recipients.

But here’s the rub: including taxes and transfers doesn’t much change the trajectory of income inequality over the past few decades. It’s grown considerably anyway you cut it.

The most commonly cited data source for comprehensive income data is from the Congressional Budget Office. The first figure below shows the trend, 1979-2010, in the Gini coefficient, a measure of income dispersion, both pre and post-tax and transfer.

Source: CBO

As you’d expect, the post-tax series is below the pre-tax one: our system of taxes and transfers is progressive and it reduces the extent of inequality in the income distribution at any point in time. But turning to trends, both series go up about the same amount over these years: 19% for the pre-tax series and 21% post-tax.

Or, look at another measure of income concentration: the share of income going to the top 1% of households. The table shows these shares for all households and those with children, along with the change in the shares over these 31 years. The post-tax changes in percentage point terms are slightly less than that pre-tax ones: by this metric, inequality rose a bit less after taxes and transfers than it did before. But rise it did!

Source: CBO

Two more points.

First, let’s be clear: in analyzing economic inequality, Piketty is by no means mistaken to examine market incomes. If, as has been the case over most of past three decades, market-based inequality generally rises, we will have to continuously ratchet up redistribution through the tax and transfer system to offset the ever more skewed primary distribution of income, aka market outcomes. That is neither good policy nor plausible politics.

In this regard, the increases in income and wealth concentration shown by Piketty are both worrisome and emblematic of a set of inequality-inducing forces firmly embedded in our economy. I can’t imagine that anyone concerned about these distributional dynamics and their impact on opportunity, growth, and the economic future of those on the have-not side of the divide will take any solace from the fact—and I’m certain it is a fact—that once you include transfers, these concentration levels are not as high as they were in the 1920s, as Robert Samuelson points out based on work by Gary Burtless (see links above)

To be clear, both of these authors recognize the trend-based point made in the figure and table above, but their arguments have confused others who interpret them as implying that there’s no increasing trend in inequality in recent decades once you account for taxes and transfers. And that’s wrong.

Second, there are those (not Burtless) who raise this “transfer defense”—the idea that the damage done to middle and low-income households by market outcomes is largely repaired by taxes and transfers—on Monday, only to turn around and argue that we can’t afford such offsets on Tuesday. Here I cite someone from the Cato Institute criticizing earlier work by Piketty and Saez based on these same market-based data for leaving out the subsidies in Obamacare! As I noted, “it is odd to favorably cite the impacts of transfers in the inequality debate while trying to significantly shrink them in the fiscal debate.”

Let’s definitely examine the most comprehensive income sources we can, but in doing so, let’s neither lose sight of the more recent inequality trends in those sources as well, nor the fundamental importance of the distribution of market-based outcomes.

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5 comments in reply to "Clarifying Some Confusion on Inequality over the Ages"

There is a market-income argument missing. It is that focusing on after taxes would be like focusing on after food. That’s because the taxes actually go to pay for something, same as purchasing food. And despite the argument from the rich that they pay more, I’d say they get more. Who benefits most from a stable and secure government, a too big to fail banking system, low crime, the rule of law, a private enterprise system that gives special privilege to those who can afford to pay? The rich contribute a larger share because their rewards are larger. But right now they pay a lower percentage because of the special treatment of capital (capital gains and qualified dividends).

But let’s not stop there. If we’re talking taxes, throw in the sales tax, the social security tax using the full 12.4% (which economists do measuring national income), 2.9% medicare tax, and lets not forget the flat and therefore regressive wealth tax also known as the property tax. We could and should get creative by throwing in gambling, vice taxes and lottery ticket purchases too, since these are known regressive tax measures. Wanna go after-tax? Really? I’m not sure conservatives have thought this through.

(last bit was off the cuff, I haven’t checked if any after tax numbers include all taxes, or what the actual impact is, somebody good with Excel google that and let me know)

And since state and local taxes are decidedly regressive on the while, these after-tax figures paint a misleading picture that should not be lost sight of in these discussions. For starters it would be helpful to refer not, as the blogpost does, to our”progressive tax system,” but to our “progressive federal tax system.”

“If, as has been the case over most of past three decades, market-based inequality generally rises, we will have to continuously ratchet up redistribution through the tax and transfer system to offset the ever more skewed primary distribution of income, aka market outcomes. That is neither good policy nor plausible politics.”

First, it’s bad policy because it’s impossible politics. Good policies are politically sustainable (eg, Soc Sec) while ever-increasing transfers are not. Also, I’m concerned that when we lean too hard on certain transfers–those for working age folks–we risk eventually subsidizing low-wage employers. Already, about a quarter of the EITC is thought to “leak out” this way. See here: http://jaredbernsteinblog.com/greg-mankiw-offers-a-false-choice-re-minimum-wage-or-eitc/